U.S. May Be Trapped in Japan-Like Deflation Within 3 Years, Schroder Says

By Masaki Kondo and Yumi Ikeda -
Aug 11, 2010

The U.S. is no longer an engine for
the global economy and may suffer deflation sometime in the next
three years, said Genji Tsukatani, head of fixed income at the
Japanese unit of Schroder Investment Management Ltd.

Ten-year Treasury yields slid to a 16-month low after the
Federal Reserve said yesterday the U.S. economic recovery will
be “more modest” than previously anticipated. The spread
between yields on U.S. and Japanese 10-year debt is at the
narrowest since May 2009.

“The aftereffects of the credit bubble along with the
aging population mean it’s possible that the U.S. will slip into
deflation” in the next three years, said Tsukatani, whose
company manages about $211 billion in assets globally. “If real
interest rates fall in the U.S., it’s likely to drag down those
in Japan.”

Tsukatani said he derives real interest rates by
subtracting inflation rates from 10-year bond yields. Deflation
increases the value of the fixed payment from bonds.

Scott Mather, head of global portfolio management at
Pacific Investment Management Co., wrote in an article this week
that “the risk is rising” that the U.S. will follow a similar
path to Japan’s. St. Louis Fed President James Bullard wrote in
a report released last month that the U.S. is “closer to a
Japanese-style outcome than any time in recent history.”

Lost Decade

Japan went through a period of stagnant growth and
continuous price declines starting in the 1990s that has been
called its “lost decade.”

Governments around the world have boosted spending over the
past two years to help their economies recover from the deepest
global recession since World War II. The U.S. government
projects its budget deficit will swell to a record $1.6 trillion
in the year ending Sept. 30.

“It’s still unclear how deep and long the economic
slowdown will be,” he said. “We have yet to figure out when
the economy will start to pick up again.”

The International Monetary Fund last month forecast the U.S.
economy will grow 2.9 percent next year, well behind China’s 9.6
percent expansion and India’s 8.4 percent.

“The U.S. hasn’t been an engine for the world’s economy
since around 2005 but it’s being driven by countries like China
and India whose economies grow 8, 9 percent,” Tsukatani said.
“With slowing population growth and more emphasis on debt
reduction, the U.S. economy probably won’t grow that much.”

A total of 12.8 percent of the U.S. population was 65 years
or older at the end of 2009, up from 11.3 percent in 1980,
Bloomberg show. That compared with 22.2 percent in Japan.